After The Dollar: What Comes Next?

THE DOLLAR'S TERRIBLE FATE

My readers are familiar with my forecast that the US dollar is in terminal
decline. America is tragically bankrupt, unable to pay its lenders without
printing the dollars to do so, and enmeshed in an economic depression. The
clock is ticking until the dollar faces a crisis of confidence like every other
bubble before it. The key difference between this collapse and, say, the bursting
of the housing bubble is that the US dollar is the backbone of the global economy.
Its conflagration will leave a vacuum that needs to be filled.

Mainstream commentators often discuss three main contenders for the role:
the euro, the yen, or China's RMB (known colloquially as the "yuan"). These
other currencies, however, each suffer from a critical flaw that makes them
unready to carry the reserve currency role in time for the dollar's collapse.
When it comes to fiat alternatives, it appears the world would be going out
of the frying pan and into the fire.

EURO: FRAYING AT THE EDGES

The euro is a ten-year-old experiment in uniting divergent political, economic,
and cultural interests under one monolithic fiat currency held in the hands
of one very powerful central bank.

If managed correctly, such a currency could serve to keep its member-governments
honest - but that is not the world in which we live. Instead, the fiscally
irresponsible members are discussing ditching the currency at the first sign
of trouble. That is, they'd rather have their own national currencies to inflate
in order to cover over their burdensome public debts. So, in order to keep
the euro together, creditor states have been strong-armed into bailouts of
the debtors - even though such measures violate the compact that created the
common currency.

The question becomes: how long do Germans - still wrought with the memory
of Weimar hyperinflation and the rise of the Third Reich - want to keep printing
euros to pay the debts of the spendthrift Greeks? How many German politicians
will ride to electoral victory on promises of unending bailouts and higher
prices across Europe? This is the fundamental flaw of the euro.

And, of course, Greece isn't the only problem. Ireland and Portugal are vying
for second-worst debt crisis in Europe. Spain, representing over 12% of eurozone
GDP, saw sovereign yields jump from 4.1% at the beginning of 2010 to 6.6% by
the end of the year. Yields on most other eurozone countries have been rising
as well - a clear indication that the eurozone is an increasingly risky bet.

While a euro secession by the PIGS could actually leave a stronger currency
region at the end, it would be a traumatic event. That prospect is undermining
confidence in the euro at just the time when the world is considering where
to go next.

Perhaps a mature currency that didn't falter so easily amidst the recent global
financial crisis would be a good contender for the world's reserve. The euro,
by contrast, is both young and in serious trouble. If less than two-dozen nations
are too immense a burden for the euro to shoulder, should we expect better
results when it's stretched across two hundred?

YUAN: CAPITALIST COUNTRY, COMMUNIST CURRENCY

The investment community is slowly coming around to my long-held excitement
about the miraculous growth of China. This is no frenzy. In fact, if anything,
I think many are still too skittish when it comes to this market. Yet, those
that are jumping on the bandwagon are now proclaiming the Chinese yuan as the
logical successor to the dying dollar. But while China is becoming an immense
economic force, the yuan itself is hobbled by the country's communist past.

Foremost, China enforces stern capital controls on the yuan. A reserve currency
must be freely and easily exchangeable with other currencies. Even within China's
borders, one cannot exchange large amounts of yuan for dollars or any other
currency.

China is slowly undertaking reforms to relieve these controls, but remember
they were not put there arbitrarily. The controls allow China to suppress the
value of the yuan, thereby maintaining artificially high exports, among other
consequences. If China allowed the yuan to trade freely, it would lose the
power it maintains over its money - and by extension, its people.

Let's remember that all fiat currencies are routinely manipulated and
inflated. The People's Bank of China has reported M2 growth of over 140% in
the past five years - almost entirely to maintain a stable exchange rate with
a depreciating dollar. Given rampant inflation, combined with exchange restrictions
and a serious lack of transparency, the yuan is simply not ready for primetime.

YEN: BLACK HOLE OF DEBT

The Japanese yen is the third amigo at the international fiat fiesta. While
it doesn't suffer the structural risks of the euro, the yen is subsisting in
an environment of massive sovereign debt. Japan's debt-to-GDP ratio is the
highest of any developed country at 225%, meaning there is a perpetual impetus
to print more yen to pay it back. The yen must endure this debt-noose, making
it a poor alternative to the USD, which suffers the very same problem.

While I believe Japan is in a much better position because it generally maintains
a net trade surplus and because most of their debt is held domestically, it's
still not a stable unit with which to conduct world trade.

Perhaps more importantly, with a world seeking yen reserves, the price of
yen would increase drastically. This is politically unpalatable in Japan, where
the export lobby is constantly trying to push the yen down to boost their sales
overseas.

These two factors combine in such a way as to make the yen a plainly infeasible
reserve currency. The appreciation in yen value would simultaneously make Japan's
debt problems worse and cause its export industry to suffer greatly, meaning
that Japan probably doesn't want this role any more than we want her to have
it.

As an aside, if you type "yen as reserve currency" into Google, it will ask, "Did
you mean:yuan as reserve currency?" I guess even the world's
smartest search engine doubts the yen could fill that role.

THE SIMPLEST ANSWER IS OFTEN THE BEST

As J.P. Morgan famously said to Congress in 1913, "gold is money and nothing
else." Morgan meant that gold was unmatched in its effectiveness as a store
of value and medium of exchange.

Given that his namesake bank started accepting physical gold bullion this
past February as counterparty collateral, why should the trend of a widespread
return to gold be considered only a remote possibility? On the contrary, it
should be expected - if for no other reason than every other currency is fundamentally
dismal.

Markets are powerful things, and require a reliable medium of exchange. The
call for sound money is not just philosophical; it is derived from the market
itself. Throughout human history, merchants have always turned to pure gold
and silver over every pretender. This is not the first experiment in a paper
money system, nor is it the first widespread debasement of money. In fact,
the lessons of history were impressed upon our well-read Founding Fathers to
the point that they included the following clear language in the Constitution: "No
state shall... make any Thing but gold and silver Coin a Tender in Payment
of Debts."

While it has always been possible that another fiat currency would rise up
to take the dollar's place, and thereby keep this irrational experiment in
valueless money going awhile longer, the particular circumstances that abound
today make it seem less and less likely to me. Instead, I'm seeing signs that
the world is moving back to gold at a breakneck speed.

This is a return to normal and has many positive implications for the global
economy. It's certainly a trend we can all welcome, and profit from.

Peter Schiff is an economist and investment advisor specializing in the foreign
equity, currency, and gold markets. He became internationally known by successfully
forecasting the collapse of the dot-com bubble, the US housing market bubble,
and the bankruptcy of major global banks. Schiff is Chairman of gold bullion
dealer SchiffGold and CEO of stock
brokerage firm Euro Pacific Capital. He
frequently delivers lectures at major economic and investment conferences,
and is quoted often in the print media, including the Wall Street Journal,
New York Times, LA Times, Barron's, BusinessWeek, Time and Fortune. His broadcast
credits include regular guest appearances on CNBC, Fox Business, CNN, MSNBC,
and Fox News Channel, as well as hosting his own weekly radio show, The
Peter Schiff Show. He is also the author of several bestselling books,
including "Crash Proof: How to Profit from the Coming Economic Collapse" released
in 2007 before the financial crisis struck, and the more recent "How An Economy
Grows And Why It Crashes" and "The Real Crash: America's Coming Bankruptcy."